ch13-AFM102s2012

So we can calculate the internal rate of return as

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Unformatted text preview: n annuity of $1 table . . . Find the 10-period row, move across until you find the factor 5.216. Look at the top of the column and you find a rate of 14%. 14% Periods 1 2 ... 9 10 Managerial Accounting 10% 0.909 1.736 ... 5.759 6.145 12% 0.893 1.690 ... 5.328 5.650 14% 0.877 1.647 ... 4.946 5.216 13-27 Internal Rate of Return Method: An Example Decker Company can purchase a new machine at a cost of $104,320 that will save $20,000 per year in cash operating costs. The machine has a 10-year life. The internal rate of return on this project is 14%. If the internal rate of return is equal to or greater than the company’s required rate of return, the project is acceptable. Managerial Accounting 13-28 Net Present Value vs. Internal Rate of Return y NPV y is easier to use. Less of an advantage now with the availability Less of IRR functions in spreadsheets such as Excel. Excel. y Questionable y Managerial Accounting assumption with IRR: Internal rate of return method assumes cash Internal inflows are reinvested at the internal rate of return. 13-29 Expanding the Net Present Value Method To compare competing investment projects we To compare competing investment projects we can use the following net present value can use the following net present value approaches: approaches: Total-cost Incremental cost Managerial Accounting 13-30 The Total-Cost Approach White Company has two alternatives: White Company has two alternatives: (1) remodel an old car wash or, (1) remodel an old car wash or, (2) remove it and install a new one. (2) remove it and install a new one. The company uses a discount rate of 10%. The company uses a discount rate of 10%. New Car W ash Annual revenues $ 90,000 Annual cash operating costs 30,000 Net annual cash inflows $ 60,000 Managerial Accounting Old Car W ash $ 70,000 25,000 $ 45,000 13-31 The Total-Cost Approach If White installs a new washer . . . Cost Productive life Salvage value Replace brushes at the end of 6 years Salvage of old equip. $300,000 10 years 7,000 50,000 40,000 Let’s look at the present value of this alternative. Managerial Accounting 13-32 The Total-Cost Approach Install the New Washer Cash Year Flows Initial investment Now $ (300,000) Replace brushes 6 (50,000) Net annual cash inflows 1-10 60,000 Salvage of old equipment Now 40,000 Salvage of new equipment 10 7,000 Net present value 10% Factor 1.000 0.564 6.145 1.000 0.386 If we install the new washer, the investment will yield a positive net present value of $83,202. Managerial Accounting Present Value $ (300,000) (28,200) 368,700 40,000 2,702 $ 83,202 13-33 The Total-Cost Approach If White remodels the existing washer . . . Remodel costs Replace brushes at the end of 6 years $175,000 80,000 Let’s look at the present value of this second alternative. Managerial Accounting 13-34 The Total-Cost Approach Remodel the Old Washer Cash 10% Year Flows Factor Initial investment Now $ (175,000) 1.000 Replace brushes 6 (80,000) 0.564 Net annual cash inflows 1-10 45,00...
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